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Bad Debt Account - What is a bad debt account?

A bad debt account holds the amounts that have been written off by the company due to customers unable to pay what is owed

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Bad debt refers to an amount that is owed by a customer on credit that is not possible for a company to collect. Initially considered an account receivable, it can then be marked as an expense under a bad debt account.

Why bad debt happens

Bad debt can occur if the customer has gone bankrupt or if the cost of continuing to attempt to collect the amount exceeds the actual amount outstanding. Bad debt is money lost by your business and as such represents an expense.

Writing-off bad debt

After all reasonable efforts have been made to collect the amount due, it can be written-off as a loss to your company. To do this, you can clear the amount from the customer ledger and place the balance in the bad debt account.

For example:

Megan’s company sells handmade tables at a cost of £200 each. Megan’s Company sells £3,000 worth of merchandise to Company X. After 90 days, three reminders, and several phone calls, Company X files for bankruptcy and it is clear that they are unable to pay the £3,000 bill.

Megan’s company has done everything possible to collect the amount owed, but now that Company X is unable to pay, she must write the £3,000 off as bad debt.

To do so, the £3,000 is added as an expense. A bad debt account is a separate account set aside specifically to handle bad debt.

Why it’s important

In business, situations do sometimes arise in which a customer is unable to pay for goods or services provided. When this occurs, it’s helpful to be prepared by having a bad debt or doubtful debt account ready.

Because this amount can impact the overall image of a company’s financial position, it is important to classify it as bad debt so that investors can see that the net income has been adjusted appropriately and that all accounts are in order.